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Q: How do you measure volatility?
A: Volatility literally represents the standard deviation of day-to-day price changes in a security, expressed as an annualized percentage. Two measures of volatility are commonly used in options trading: historical and implied. Historical volatility depicts the degree of price change in an underlying security observed over a specified period of time using standard statistical measures. It is not a forecast of future volatility. Implied volatility is the market's prediction of expected volatility, which is indirectly calculated from current options prices using an option-pricing model. The exact formula for historical volatility is:
Q: Can you explain what the term "Zeta" means?
A: Zeta is the market value of an option, less its model value using the at-the-money implied volatility for the same expiration. It is a measure of the importance of using the volatility smile, rather than only ATM volatility. A nice dictionary of derivatives terms can be found at
http://www.margrabe.com/Dictionary.html.
Source: Howard Savery, "Quantifying Volatility Convexity," Derivatives Strategy, 2/2000, pp. 54-55.
Q: I am perplexed when the option premium disappears from my options. I paid $6.40 for a $20 call with two years until expiration when the stock was trading at $20/share. Now the stock is above $50, but the premium has totally disappeared. The option still has 18 months to expiration and I don�t understand why the premium went away so quickly, it seems like I lost $6.40 somewhere.
A: What you have described below is the phenomenon of delta. Delta is defined as the ratio of the theoretical price change of the option to the price change of the underlying stock. The rule of thumb is that an at-the-money option has a delta of approximately 50%. Since your call option was right at-the-money when you bought it, for each $1 that the stock went up your option increased by 50 cents. As the stock continued to increase, so did the value of the option, but ALWAYS AT A SLOWER RATE THAN THE STOCK.
At some point the delta of your option approached 100% and it began to move at the same rate as the stock. But during that time, the movement of the stock outpaced that of the option by $6.40, the amount of your premium. If the stock fell back toward $20 the process would reverse itself and you would see some time value premium reappear.
Q: What is a put/call ratio and how is it used?
A: The put-call ratio is simply the number of puts traded divided by the number of calls traded. It can be computed daily, weekly, or over any time period. It can be computed for stock options, index options, or future options. Some market technicians suspect that a high volume of puts relative to calls indicates investors are bearish, whereas a high ratio of calls to puts shows bullishness.
Many market technicians find the put-call ratio to be a good contrary indicator, meaning when the ratio is high, market bottom is near, and when the ratio is low, a market top is imminent. The more highly traded options contracts produce a more reliable put-call ratio. Traders and investors generally buy more calls than puts where stock options are concerned. Therefore, the equity put-call ratio is a number far less than 1.00. If call buying is heavy, the equity put-call ratio may dip into the .30 range on a daily basis. Very bearish days may occasionally produce numbers of 1.00 or higher. An average day will produce a ratio of around .50 - .70.
Once again, the numbers are interpretive numbers. Here are some numbers that may be used for illustrative purposes:
Index P/C Ratio
Bullish 1.5 or higher
Bearish .75 or lower
Neutral .75-1.5
Equity P/C Ratio
Bullish .75-1
Bearish .4 or lower
Neutral .4-.6
The Option Industry Council's website provides two sources for put/call ratios:
Excel or Text format or use the
Volume Query.
Q: Can you please help me understand what is the meaning of "skew" in options?
A: The basic idea behind skew is that options with different strike prices and different expirations tend to trade at different implied volatilities. When implied volatilities for options with the same expiration are plotted, the graph resembles a smile, with at-the-money volatility in the middle and out-of-the-money options forming the gently-rising sides. As options go into the money they gradually approach their intrinsic value, and an option trading at its intrinsic value has an implied volatility of zero, so for our graph we use call prices for strikes above the current underlying stock price and put prices for strikes below the current underlying stock price.
There is a mathematical reason that skew appears as the "volatility smile" described above: most option pricing models assume stock prices are log-normally distributed, but in the real world stock prices deviate slightly from that model. Specifically, the Normal Distribution underestimates the probability of extremely large moves. In order to compensate, traders �tweak� their models by using a higher volatility for out-of-money options.
But the skew also holds valuable information. An investor who takes the time and effort to carefully analyze the skew of a stock�s options can gain important insights into how the market is pricing risk. In some cases, for example, the perceived downside risk may be greater than the perceived upside risk, which causes the graph to be more of a �smirk� than a �smile�.
Q: Where can I find option delta values on the internet?
A: Delta is one of the options greeks that is derived from an option pricing module. Delta, normally expressed as a percetnage, seeks to measure the rate of change in an options' theoretical value for a one-unit (i.e. $1) change in the price of the underlying security or index. There are a couple of ways to obtain the "delta" of an option.
1) From OIC website,
www.888options.com, you can click on the menu link titled "Trading Desk". then click on the the link "Options Quotes". The information you will need to enter on the "delayed quotes" screen is self-explanatory. You will notice a box that says "Just give me the Greeks". Click that box and you will get the options' Greeks, including the delta.
2) You can also solve for the option delta using our options calculator. There is an options pricing calculator available on our website. This calculator is available in either a Basic or Advanced format. First time users are encouraged to review the Basic calculator as there are discussions on the various inputs necessary to calculate an options' theoretical pricing.
Q: Is there an easy way to determine the first three characters of an options contract? I see that there can be multiple symbols for options on the same underlying stock.
A: There is no easy way for determining options root symbols, so let me give you some general guidelines. For NYSE stocks, the options root and the stock root are usually the same. For example, IBM options begin with IBM, and T options begin with T. Options roots, however, can never have more than three letters. So options root symbols for NASDAQ stocks are different than the stock symbols. Microsoft, for example, has the symbol MSFT for the stock and MSQ for the root options symbol. And Intel has INTC for the stock and INQ for the options.
The last two letters after the options root symbol indicate (1) the options type and expiration month and (2) the strike price.
One complication is that, when a stock's price range is greater than $100, then the option root symbol has to change for every $100. Otherwise, the 105, 205 and 305 calls would have the same symbols, and that obviously cannot happen.
Another complication, as you pointed out, is that the same strike-price options sometimes have different root symbols. This typically occurs when there are 3-for-2 or other "non-even" stock splits. When these splits occur, there are "non-standard" options in addition to "standard" options. For standard options contracts, 100 shares typically underlie the contract, and non-standard options will have some other quantity. If a $60 stock splits 3-for-2, for example, then, after the split, there would be standard $40 options covering 100 shares and non-standard options covering 150 shares. To distinguish between them they each have their own root symbol.
If you are considering trading options on a particular stock for the first time, I suggest you get the ticker symbol from a reliable options quote vendor or contact an Options Industry Services representative at 1-888-OPTIONS (678-4667), Monday - Friday, 7:30 a.m. - 5:00 p.m. CST. That way you will know, for sure, that you have the correct symbol. With a little practice , it will all become clear.
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